US hedge funds cut short positions before freeze
Hedge funds in the US cut most of their short positions in domestic equities before new restrictions took effect last week, according to fresh research that suggests short selling had little to do with the falls in financial stocks.
The US and UK financial regulators last week stopped investors from establishing or increasing short positions in financials stocks, blaming short positions for recent falls in the value of financial companies.
Short-selling is the practice of borrowing securities from a lender, selling them, and later buying them back to return them to their original owner. If the buy-back price is lower than the sale price, the short-seller can book the profit. As a result, it is possible to profit from a share price falling in value.
However, a report by analysts at French bank Société Générale's cross asset research unit yesterday said that net short positions of the S&P 500 index fell to almost zero before the Securities and Exchange Commission applied a blanket ban on shorting financials stocks last week.
The report cited figures from the Commodity Futures Trading Commission, a US derivatives regulator. Net short positions on the Russell 2000 index also fell by about three quarters over the last two months after remaining relatively stable over the last year, according to the Société Générale report.
The report said: "The latest CFTC report available did not take into account the recent announcement which structurally restricts the short selling capability on some equities classes. Ahead of this announcement, net selling positions had been already substantially reduced on all types of equities. This trend should be amplified by this event."
Levels of stock borrowing, which are used as a proxy to judge shorting levels, were relatively low last Friday, according to UK analyst DataExplorers (see related story). Borrowing levels are usually in the low single digits.
Of stock available to be lent from selected US financial services companies, 8% of available stock for AIG was lent out; 4% of available Merrill Lynch stock; 4.7% of Morgan Stanley; 2% of Bank of America; and 3.7% of Goldman Sachs.
The statistics are likely to reignite frustration over the ban on shorting financial stocks, which both US and UK regulators established on the basis that widespread short positions contributed to the recent collapse in valuations.
Regulators and investors clashed last week over the restrictions.
Christopher Cox, the SEC chairman, said last week: "It appears that unbridled short selling is contributing to the recent, sudden price declines in the securities of financial institutions unrelated to price valuation."
Callum McCarthy, chairman of the FSA, also said in a speech last week: “There is a danger in a trading system which allows financial institutions to be targeted and subject to extreme short selling pressures, because movements in equity prices can be translated into uncertainty in the minds of those who place deposits with those institutions with consequent financial stability issues. We have seen acute examples of this phenomenon in both London and New York this week".
After imposing the ban, the UK's Financial Services Authority also said that it "stands ready to extend this approach to other sectors if it judges it to be necessary".
Industry bodies and hedge funds cried out against the restrictions on short positions. Andrew Baker, chief executive of global hedge fund body the Alternative Investment Management Association, said: "Without shorting you have less efficient markets and less efficient price discovery and liquidity, and without shorting you will have a market that is lower for longer".
The UK's Investment Management Association said that "short selling of bank shares is neither the sole nor the principal reason for the falls in the price of certain shares in recent weeks".
Ian Morley, chairman of hedge fund manager Corazon Capital, added that markets fell because they had "gone up with irrational exuberance and liquidity and they have now probably fallen too far because there is a lack of liquidity and that's about fear, but fear is stronger than greed".
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